McAllister v. Commissioner of Internal Revenue

• Decision Date: 06 August 1946
• Docket Number: Docket 20178.,No. 266,266
• Parties: McALLISTER v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Second Circuit

157 F.2d 235 (1946)

McALLISTER v. COMMISSIONER OF INTERNAL REVENUE.

No. 266, Docket 20178.

Circuit Court of Appeals, Second Circuit.

August 6, 1946.

Charles B. Collins, of Jersey City, N. J. (James D. Carpenter, Jr., of Jersey City, N. J., and William Diebold, of New York City, on the brief), for petitioner.

L. W. Post, Sp. Asst. to the Atty. Gen. (Sewall Key, Acting Asst. Atty. Gen., and Helen R. Carloss, Sp. Asst. to the Atty. Gen., on the brief), for respondent.

Before SWAN, CLARK, and FRANK, Circuit Judges.

CLARK, Circuit Judge.

This petition for review presents the question whether the sum of $55,000 received by petitioner on "transfer" or "surrender" of her life interest in a trust to the remainderman constitutes gross income under I.R.C. § 22(a), 26 U.S.C.A. Int.Rev. Code, § 22(a), or receipts from the sale of capital assets as defined in I.R.C. § 117(a) (1), 26 U.S.C.A. Int.Rev.Code, § 117(a) (1). As we shall see, some significance seemingly is attached to a choice between the two words set in quotation marks as a description of the transaction. Petitioner contends that the life estate was a capital asset, the transfer of which resulted in a deductible capital loss, leaving her with no taxable income for the year. A majority of the Tax Court agreed with the Commissioner that the receipt in question was merely an advance payment of income, while four judges dissented, Judges Opper and Disney writing the opposing opinions. 5 T.C. 714.

The will of Richard McAllister established a trust fund of $100,000, the income of which was to be paid to his son John McAllister for life and, on the latter's death without children, to John's wife, the petitioner herein. On her death, the trust was to terminate, the residue going to the testator's wife and his son Richard. The testator died in 1926, his widow in 1935, and John in 1937. Except for stock in the R. McAllister corporation, not immediately salable at a fair price, John left assets insufficient to meet his debts; and in order to obtain immediate funds and to terminate extended family litigation according to an agreed plan, petitioner brought suit in the Court of Chancery of New Jersey to end the trust. The parties then agreed upon, and the court in its final decree ordered, a settlement by which the remainderman Richard, in addition to taking over the stock for $50,000, was to pay petitioner $55,000, with accumulated income and interest to the date of payment, in consideration of her release of all interest in the trust and consent to its termination and cancellation. Receiving payment on July 19, 1940, petitioner, in accordance with the court order, executed a release, providing: "I do further consent and agree that my estate in the aforesaid trust, created under the third paragraph of the * * * will * * * shall be and the same is hereby terminated absolutely, and I do decline to accept further any benefits therefrom or interest therein." For the year 1940, she reported a capital loss on the transaction of $8,790.20, the difference between the amount received and the value of the estate computed under I. T. 2076. The Commissioner disallowed the loss and made the deficiency assessment which was upheld by the majority below.

The issue, as stated by the Tax Court and presented by the parties, reduces itself to the question whether the case is within the rule of Blair v. Commissioner of Internal Revenue, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465, or that of Hort v. Commissioner of Internal Revenue, 313 U.S. 28, 61 S.Ct. 757, 85 L.Ed. 1168. In the Blair case, the life beneficiary of a trust assigned to his children specified sums to be paid each year for the duration of the estate. The Supreme Court held that each transfer was the assignment of a property right in the trust and that, since the tax liability attached to ownership of the property, the assignee, and not the assignor, was liable for the income taxes in the years in question. The continued authority of the case was recognized in Helvering v. Horst, 311 U.S. 112, 118, 119, 61 S.Ct. 144, 85 L.Ed. 75, 131 A.L.R. 655, although a majority of the Court thought it not applicable on the facts, and in Harrison v. Schaffner, 312 U. S. 579, 582, 61 S.Ct. 759, 85 L.Ed. 1055, where the Court very properly distinguished it from the situation where an assignor transferred a portion of his income for a single year. We think that its reasoning and conclusion support the taxpayer's position here. It has been relied upon by other cases cited below which we find indistinguishable from the present case.

Petitioner's right to income for life from the trust estate was a right in the estate itself. Had she held a fee interest, the assignment would unquestionably have been regarded as the transfer of a capital asset; we see no reason why a different result should follow the transfer of the lesser, but still substantial, life interest. As the Court pointed out in the Blair case, the life tenant was entitled to enforce the trust, to enjoin a breach of trust, and to obtain redress in case of breach. The proceedings in the state chancery court completely divested her of these rights and of any possible control over the property. The case is therefore distinguishable from that of Hort v. Commissioner of Internal Revenue, supra, where a landlord for a consideration cancelled a lease for a term of years, having still some nine years to run. There the taxpayer surrendered his contractual right to the future yearly payments in return for an immediate payment of a lump sum. The statute expressly taxed income derived from rent, Revenue Act of 1932, § 22(a), 26 U.S.C.A. Int.Rev.Acts, page 487; and the consideration received was held a substitute for the rent as it fell due. It was therefore taxed as income.

What we regard as the precise question here presented has been determined in the taxpayer's favor on the authority of the Blair case by the Eighth Circuit in Bell's Estate v. Commissioner of Internal Revenue, 8 Cir., 137 F.2d 454, reversing 46 B.T.A. 484. This case, in turn, has been followed by the Tax Court in Harman v. Commissioner of Internal Revenue, 4 T.C. 335, acquiesced in by the Commissioner, 1945-6 Int.Rev.Bull. No. 6, p. 1, and by the District Court in First Nat. Bank & Trust Co. in Macon v. Allen, D.C.M.D.Ga., 65 F.Supp. 128. See also Quigley v. Commissioner of Internal Revenue, 7 Cir., 143 F.2d 27; Estate of Camden v. Commissioner of Internal Revenue, 47 B.T.A. 926, affirmed 6 Cir., 139 F.2d 697; Randall v. Randall, D.C.S.D.Fla., 60 F.Supp. 308, 313, 314.

The Tax Court and the government have attempted to distinguish both the Bell and the Blair cases on grounds which seem to us to lack either substance or reality. The principal ground seems to be the form the transaction assumed between the parties. Thus the Court says that petitioner received the payment for "surrendering" her rights to income payments, and "she did not assign her interest in the trust, as did petitioners in the Bell case." But what is this more than a distinction in words? Both were cases where at the conclusion of the transaction the remaindermen had the entire estate and the life tenants had a substantial sum of money. There surely cannot be that efficacy in lawyers' jargon that termination or cancellation or surrender carries some peculiar significance vastly penalizing laymen whose counsel have chanced to use them. And the fact that the whole affair was embodied in a court decree can add nothing more than a seal of legal validity to it. What was practically accomplished remained the same. And that here, as in the Bell case, there was a "surrender" to the remainderman, rather than a "transfer" to third persons as in the Blair case, does not change the essentially dispositive nature of the transaction so far as the former property owner is concerned.

Other suggestions seem equally dubious. Thus it is said that the transfer in the Blair case was without consideration. But it is hard to see how this affects either the fact or the validity of the transfer; if anything, the odds should favor the conveyance for a consideration — the income of which will yield taxes in the future. Naturally, since there were no capital gains or losses, the Blair case does not discuss them. (Actually it cites neither the gross income nor the capital assets statutes.) But its holding that the assignment leaves no taxable income with the assignor is just as potent here on the like point, even though we do have the further problem posited by the claim of a capital loss. And there was very definitely a consideration paid in the Bell case. Next it is urged that there could be no assignment because this was a spendthrift trust where the creator had forbidden assignment or anticipation by a beneficiary. (The form of prohibition here was an express command as to a vested equitable interest; there was no grant of discretionary power to the trustees to withhold income.) But the answer is that it was done by a series of transactions affirmed by the state court. That is, the trust provisions made passing of the interest somewhat more difficult, but not beyond the ingenuity of lawyers, when the parties were agreed. So in the Blair case the government argued that the trust was a spendthrift trust under Illinois law. Said the Court, 300 U.S. 5, 10, 57 S.Ct. 330, 332, 81 L.Ed. 465: "The point of the argument is that, the trust being of that character, the state law barred the voluntary alienation by the beneficiary of his interest. The state court held precisely the contrary. The ruling also determines the validity of the assignment by the beneficiary of parts of his interest. That question was necessarily presented and expressly decided."

Setting the bounds to the area of tax incidence involves the drawing of lines which may often be of an arbitrary nature. But they should not be more unreal than the circumstances necessitate. Here the line of demarcation between the Blair...